Friday, September 28, 2012
Kentucky Has Some Strange Laws – Snakes and Reptiles in Religious Services
Notwithstanding the oft reported handling of snakes in certain religious services, typically reported when one of the handlers suffers a bite and subsequently dies, doing so is actually illegal in Kentucky. Under KRS § 437.060, it provided that:
Any person who displays, handles or uses any kind of reptile in connection with any religious service or gathering shall be fined not less than fifty dollars ($50) nor more than one hundred dollars ($100).
Thursday, September 27, 2012
Default Judgment Upheld by Court of Appeals
The Court of Appeals, in a July decision, has upheld a default judgment entered against a combination of entity and individual defendants where, it appears, no responsive pleadings were ever filed. True Gospel Church Ministries, Inc. v. Church of God in Christ, No. 2011-CA-000796-MR, 2012 WL 2604268 (Ky. App. 2012).
Cloesey Henderson established, in the early 1980s, the True Gospel Church of God in Christ (the “TGC”), which in turn affiliated with the National Church of God in Christ (the “National Church”), being then assigned to its Kentucky first jurisdiction. TGC thereafter obtained two pieces of real property upon which it constructed a church. In 2008, Cloesey died, leaving as survivors his widow, Carthel, a son, David, and a daughter, Shirley. Thereafter, the National Church appointed a replacement pastor for TGC. Cloesey’s heirs were dissatisfied with that appointment and, in concert with some or all of the congregation, formed the True Gospel Church Ministries, Inc. (“TGCMI”). Then, purportedly as representatives of TGC, David, Shirley and Carthel transferred the real property to TGCMI. TGCMI then affiliated with the Church of God in Christ International (the “International Church”).
The National Church instituted suit against TGCMI and each of David, Shirley and Carthel on the basis that the real property belonged to the National Church and that they had no authority to transfer it to TGCMI. A bishop of the International Church filed a document designated as a response to the complaint, ostensibly on behalf of TGCMI. However, as this bishop was not an attorney, this document was not treated as a responsive pleading.
More than eight months after the filing of the complaint, the plaintiffs moved for a default judgment or a summary judgment. On the date scheduled for the hearing on the motion for default or summary judgment, it was represented to the court that counsel had been hired on behalf of TGCMI and possibly the individual defendants whereupon the court directed the attorney to enter an appearance and file an answer. He, in turn, filed that appearance but only on behalf of TGCMI, and on its behalf filed a response in opposition to the motion for default/summary judgment. No answer was filed on behalf of the individual defendants or TGCMI.
A hearing was scheduled on the motion for default/summary judgment, but TGCMI’s counsel failed to appear thereat. The hearing was re-scheduled, and TGCMI’s counsel again failed to appear. Taking the matter under advisement, the court then granted the motion for a default judgment. In doing so, the court noted that no appearance or answer had been entered on behalf of any of the individual defendants, and no answer had been filed on behalf of TGCMI.
Just over two weeks after the entry of that default judgment, new counsel entered an appearance on behalf of all of the defendants and filed a motion for leave to file an answer and as well a motion to alter, vacate or amend the grant of the default judgment. Still, the default judgment was entered, and appeal was taken to the Court of Appeals.
Reciting that the question is one of the trial court’s abuse of discretion, the Court of Appeals reviewed the factual posture of the case below. The appellants, the defendants below, argued that it was an abuse of discretion to enter a default judgment “because the responsibility for not filing an answer properly belong[ed]” to their attorney and not to themselves. Rejecting that argument, it was noted that a default judgment may be entered when no defense is entered. While an entry of appearance was made on behalf of TGCMI, nothing precluded the individual defendants from representing themselves. Further, while that counsel “might be at fault for failing to file an answer on behalf of [TGCMI], he cannot be at fault for failing to file an answer on behalf of [the individual defendants] because he did not represent them.”
In response to the argument that the trial court should have vacated its default judgment pursuant to CR 55.2 for good cause shown, such was rejected in that “[c]arelessness by a party or his attorney is not reason enough to set an entry aside,” citing S.R. Blanton Dev. Inc. v. Investors Realty and Management Co., Inc., 819 S.W.2d 727, 729 (Ky. App. 1991).
Wednesday, September 26, 2012
Is the Charging Order Receiver Acting as a Receiver for the LLC Itself?
In a recent decision of the Bankruptcy Court for Montana, it appears, most curiously, that a receiver appointed to receive distributions diverted under a charging order is being permitted to act as a receiver for the entire LLC and supervise its assets. In re Jonas, No. 10-60248-11, 2012 WL 2994724 (Bkrtcy. D. Mont. July 23, 2012).
This decision arises out of what has apparently been a long dispute between Edwin Jonas (“Jonas”) and his former spouse Linda. Jonas held either a 50% or 100% interest in Blacktail Mountain Ranch Co., LLC. Linda had been awarded a charging order as well as a receiver in respect thereto against Jonas’ interest in Blacktail. Much of this decision is focused upon his efforts, ultimately unsuccessful, seeking injunctive relief against the activities of that receiver and the enforcement of the charging order.
It was stated that the cattle owned by the LLC were running loose. In determining that injunctive relief was not in order, the Court wrote that:
Linda seeks to have the receiver placed into possession of the LLC in order to protect the LLC assets. Jonas has admitted in his testimony that he failed to keep control of the LLC’s cattle. The LLC’s cattle appeared to be in more harm under his control that they would be under a receiver’s control.
Something strange is here taking place. A receiver appointed in connection with a charging order is authorized, on the judgment-creditor’s behalf, to receive the distributions that would have otherwise gone to the judgment-debtor. This is a limited faculty that does not entail control of the LLC itself. As the holder of a charging order is not authorized thereby to have a voice in the management of affairs of the venture, likewise the charging order receiver has no voice. Were this clearly a single-member LLC, the Court might have been, at least subconsciously, applying the rule of In re Albright to in effect treat the holder of the charging order against the sole interest in an LLC as creating dominion over the LLC’s assets. See, e.g., Thomas E. Rutledge & Thomas Earl Geu, The Albright Decision - Why a SMLLC is Not an Appropriate Asset Protection Vehicle, 5 Business Entities 16 (Sept./Oct., 2003. On the other hand, the Court acknowledged that there is a possibility that the LLC has another member, noting that they would need to protect their interests in that LLC in the Montana state court proceeding wherein the charging order had been first awarded.
Something here is just not right.
Tuesday, September 25, 2012
Delaware Law Applied to Pre-Incorporation Agreement
Recently, the Business Law Court of North Carolina addressed the question of choice-of-law as to an agreement to issue shares in a Delaware corporation. Notwithstanding that the contract was entered into in North Carolina, the corporation, incorporated in Delaware, having its principal place of business North Carolina and the plaintiff’s residency in North Carolina, it was held that Delaware law would apply. Mancinelli v. Momentum Research, Inc., 2012 NCBC 28 (May 17, 2012).
Mancinelli was recruited from her existing employment in North Carolina to join Momentum Research on terms including the issuance to her of 15% of the company’s stock (or at least she so alleged). She asserted as well that she signed a shareholder agreement, but the company was unable to produce a copy of that document and disputed its existence; she had no copy. There was, however, other evidence of an agreement to issue the stock to Mancinelli. The question arose as to whether Delaware law or that of North Carolina should be applied in assessing the claims for breach of the agreement to issue the stock.
The court relied primarily upon principles set forth in the Restatement of Conflicts as to the internal affairs doctrine (Restatement (2nd) of Conflict of Laws, § 302 (1971)), it providing that the law of the state of incorporation governs a number of matters particular to the relationship of the shareholders and the corporation, including the issuance of shares. The fact of the defendant’s principal place of business, the plaintiff’s residency and that the contract was entered into in North Carolina were held not sufficient to override these principles on the basis that “North Carolina has the most significant relationship to the contracts and parties at issue.” Slip op. ¶ 16.
Applying Delaware law, which does not enforce an oral agreement to issue shares, the plaintiff’s complaint was, to the extent of that count, dismissed. However, to the extent her complaint was based upon the breach of the alleged written shareholder agreement, it was allowed to proceed.
Kentucky Has Some Strange Laws – Dueling
The Kentucky Constitution is rather (in)famous for its constitutional provision requiring that all public officers (including attorneys) swear that they have not participated, directly or as a second, in a duel. Ky. Const. § 239. Many are unaware, however, that there is as well a statutory limitation on dueling applicable to everyone in the Commonwealth:
Any person who, in this state, challenges another to fight with any deadly weapon, in or out of this state, and any person who accepts the challenge, shall be fined five hundred dollars ($500) and imprisoned for not less than six (6) and no more than twelve (12) months. KRS § 437.030.
In addition, there is as well liability for anyone who carries or delivers the challenge to a duel.
Monday, September 24, 2012
Holder of Charging Order Not Entitled to Company Financial Records
In a recent decision rendered by the Iowa Court of Appeals, it was held that the holder of a charging order is not entitled, with respect to the LLC of whose interests have been charged, to the LLC’s cash flow statements. Wells Fargo Bank, N.A. v. Continuous Control Solutions, Inc., No. 2-431 / 11-1285 (Iowa Ct. App. Aug. 8, 2012). The primary review of the facts of the underlying dispute are set forth at Wells Fargo Bank, N.A. v. Continuous Control Solutions, Inc., No. 10-1070, 2011 WL 2695269 (Iowa Ct. App. July 13, 2011).
A group of individual judgment-creditors obtained a judgment against a group of individual judgment-debtors. Seeking to collect on that judgment, the judgment-creditors applied for charging orders against the judgment-debtors’ interests in three LLCs that they owned collectively and as well interest in two other LLCs in part owned by one of the judgment-debtors. In connection that request for a charging order, the judgment-creditors requested that the LLCs “disclose their cash flow statements or other documentation ‘in order to verify no distributions had been made to the judgment-debtors or any other entity or person with an ownership interest in these limited liability companies.’” Slip op. at 3. In turn, the LLCs objected to the requirement to disclose their financial information. Ultimately, the trial court did order the disclosure of that information every six months.
Cutting to the chase:
On appeal, the LLCs argued there is no statutory authority for the disclosure orders issued by the district court. We agree. Slip op. at 4.
The court recognized that the Iowa LLC charging order provision does authorize the issuing court to “[m]ake all of the orders necessary to give effect to the charging order,” but held that this language did not authorize the sought requirement of financial information disclosure. Ultimately, it determined that this provision applied only with respect to a receiver appointed by the court to receive the distributions. The court noted as well that as the holder of a charging order is one step removed from being a transferee of the charged economic interest, and as a transferee of an economic interest is not entitled to access company records; no right to company information should be available:
A charging order constitutes a mere lien on the judgment-debtor’s transferrable interest (the member’s economic interest) in the L.L.C. [Iowa Code] § 489.503(1). If a transferee of a member’s economic interest is not entitled to access to the L.L.C.’s records, the holder of the lien upon the member’s economic interest should be similarly denied access to the L.L.C.’s records or other information concerning the company’s activities, unless otherwise authorized by statute.
This decision, at least as to the rights of the holder of a charging order to information, should be good law in Kentucky (whether the implication that information could be compelled to be shared with a receiver requires further analysis). Under Kentucky law, it is express that the holder of a judgment lien “has only the rights of a transferee and shall have no right to participate in the management of or to cause the dissolution of the partnership.” KRS § 362.1-504(2); see also KRS § 275.260(2) (equivalent provision in the Kentucky LLC Act). As transferees do not have information rights, the holder of a charging order should likewise lack information rights.
Friday, September 21, 2012
Kentucky Has Some Strange Laws – Working on Sunday
There are some strange things in Kentucky Revised Statutes. For reasons that entirely escape me, I recently stumbled upon a statute that imposes a penalty for working on Sunday. It provides in part:
Any person who works on Sunday at his own or at any other occupation or employees any other person, in labor or other business, whether for profit or amusement, unless his work or the employment of others is in the course of ordinary household duties, work of necessity or charity or work required in the maintenance or operation of a public service or public utility plant or system, shall be fined not less than two dollars ($2) nor more than fifty dollars ($50). The employment of every person employed in violation of this subsection shall be deemed a separate offense. KRS § 436.160(1).
There is an exception in the statute for grocery and drug stores, gas filling stations, movie theatres and fishing tackle/bait shops. KRS § 436.160(3).
The following section of KRS goes on to permit counties and cities to permit other Sunday sales. KRS §§ 436.165(1)-(3). However, even under that permission, no retail establishment is permitted to be open on Sunday between 6 a.m. and noon. KRS § 436.165(4)(c). I am at a loss to explain my Sunday morning runs to Target and Lowes.
Thursday, September 20, 2012
Class Action Arbitration – Conception Applied by Ky. Supreme Court
In Schnuerle v. Insight Communications Co., L.P., No. 2008-SC-0007789-DC (Ky. Dec. 10, 2010), in reliance upon the Ninth Circuit’s Discover Bank decision (Discover Bank v. Superior Court, 113 P.3d 1100 (9th Cir. 2005), the Kentucky Supreme Court struck down the provision of an arbitration agreement precluding class action arbitration. While a motion for rehearing or reconsideration was pending, the U.S. Supreme Court issued its decision in AT&T Mobility, LLC v. Conception, ___ U.S. ___, 131 S.Ct. 1740 (2011), in which it upheld a class action arbitration waiver and overturned Discover Bank. The case was reargued to the Kentucky Supreme Court, and it has reversed its prior decision, now upholding the waiver of a class action arbitration. Schnuerle v. Insight Communications Co., L.P., __ S.W.3d __, 2012 WL 39631378 (Ky. Aug. 23, 2012).
Aside from upholding the waiver of class action arbitration, a result compelled by the Supreme Court’s Conception decision, the Schnuerle decision has a number of interest elements. Before turning to them, as to waivers of class action arbitration, the Kentucky Supreme Court wrote:
[U]pon application of Concepcion, we are now constrained to conclude that under contracts like the one now before us, which contain a class action waiver and also require disputes to be arbitrated under the FAA, the federal policy favoring arbitration preempts any state law or policy invalidating the class action waiver as unconscionable based solely upon the grounds that the dispute involves many de minimis claims which are, individually, unlikely to be litigated. We are satisfied that Concepcion is dispositive, and therefore, we turn our discussion to its application in this case. 2012 WL 3631378, *5.
Justice Schroder wrote a partial dissent, joined in by Justice Noble, that would have struck the agreement to arbitrate on the grounds that it is unconscionable. 2012 WL 3631378, *15-16. That determination followed from Insight’s position as the monopoly supplier of broad-band internet services and its requirement that customers agree to arbitration.
Choice of Law
While the agreement contained a New York choice-of-law clause, the Supreme Court determined that Kentucky law would apply. Reviewing Kentucky’s law on the respect granted (or not) choice-of-law elections, including § 188 of the Restatement (2nd) of Conflicts, the Court wrote:
Upon application of Breeding [v. Mass. Indem. and Life Ins. Co., 633 S.W.2d 717 (Ky. 1982)], we agree with the circuit court's conclusion that Kentucky law governs our evaluation of the Service Agreement. Appellants, the other members of the putative class, the Internet equipment, the Internet service provided, and the relevant operating area are all located in Kentucky. The customers executed the agreements in Kentucky, and Kentucky has a substantial interest in the protection of its residents in the area of commercial transactions. Moreover, one of the principal claims arises under the Kentucky Consumer Protection Act. New York, on the other hand, has no discernible connection or interest at all in the subject matter of this litigation. Thus, there can be no doubt that Kentucky has “the greater interest and the most significant relationship to the transaction and the parties.” 2012 WL 3631378, *4.
The FAA Controls
The agreement at issue provided:
The arbitration process established by this section is governed by the Federal Arbitration Act (“FAA”), 9 U.S.C. §§ 1–16. The FAA, not state law, shall govern the arbitrability of all disputes between Insight regarding this Agreement and the Service. 2012 WL 3631378, *9.
While both parties agreed that the arbitration agreement is subject to the FAA, the Court noted that “the contract for Internet service which is the subject matter of the contract clearly involves an interstate (indeed worldwide) service….” 2012 WL3631378. *10, footnote 11.
A number of points remain unresolved after this ruling including:
· In an agreement governed by the Kentucky (versus the Federal) Arbitration Act, is a class action waiver effective?
· Absent an agreement involving interstate commerce, will an election to be governed by the FAA always be respected?
· What is the analytic path for determining, absent a contractual election, whether a particular agreement to arbitrate will be governed by the KyAA or the FAA?
· Applying the majority decision, what more or different in an agreement to arbitrate would lead to a conclusion of either substantive or procedural unconscionability?
Veil Piercing Claim Is Not Supported by Property Transfers Between Georgia LLC and Its Members
Here is an excellent review by Doug Batey of a recent Ga decision on an attempt to pierce an LLC
Here is an excellent review by Doug Batey of a recent Ga decision on an attempt to pierce an LLC
Thursday, September 13, 2012
Award of Damages Reversed for Failure to Conform to the Evidence
In a recent decision by the Kentucky Court of Appeals, it reversed an award of damages to the plaintiff that did not conform to the damages placed in evidence even though it was less than the damages sought and the same amount requested by plaintiff’s counsel in his closing argument. Pennington v. Wheeler and Clevenger Oil Co., 2012 WL 3762031 (Ky. App. Aug. 31, 2012) (Not To Be Published). This was the second trip of this particular dispute to the Court of Appeals, it having in 2009 reversed a damage award of only $10.00. 2009 WL 792736 (Ky. App. Mar. 27, 2009) (reviewed denied Oct. 21, 2009).
Briefly, Pennington had granted to Wheeler and Clevenger Oil Co. (“Wheeler”) an option to acquire a convenience store for which Wheeler had an exclusive supply agreement for gasoline. Pennington did not do so, transferring the lease rather to Trador. At the first trial, it had been demonstrated that Wheeler had incurred damages (i.e., loss profits) in the amount of $162,968.64 over a projected lease period of 32 months. At the second trial, Mark Clevenger, a co-owner of Wheeler, testified to losses incurred of $583,013.81. Also introduced into evidence was the lease between Pennington and Trador, showing that it obligated Trador to pay to Wheeler $4,000 per month for a total of $236,000 over a projected 59-month period. However, even as Clevenger had testified to damages exceeding $583,000, in his closing arguments counsel sought an award of $236,000 from the jury, that being the amount to be paid to Pennington by Trador under the lease, it being stated by Wheeler’s attorney that “his client would be ‘happy’ with that amount and thought it would be ‘fair’.” 2012 WL 3762031, *3, fn 4.
Pennington appealed on the basis that the jury’s award of damages was not based upon substantial evidence. The Court wrote that:
It is well established in this jurisdiction that the measure of damages for breach of contract is that sum which will put the injured party into the same position he would have been had the contract been performed.
To that end, the jury had been instructed that:
You will determine from the evidence and award [Wheeler] a sum of money that will fairly and reasonably compensate it for the loss of profit it sustained, directly as result of the failure of [Pennington] to comply with the right of first refusal, not to exceed $583,013.81. Id.
In overturning the jury’s verdict, the Court wrote that:
We conclude the jury disregarded the instruction because there was no evidence which supported an award of $236,000 as a measure of lost profit. The evidence was that Wheeler’s lost profit was either $583,013.01 or $0. A jury is ordinarily permitted to award damages, in its discretion, which are less than the amount sought by the plaintiff, but more than the amount admitted by the defendant….
Here, however, the jury award cannot stand because in awarding the exact amount of rental payments, the jury clearly disregarded the instructions…. The jury disregarded the instruction to arrive at an amount of damages based upon Wheeler’s lost profit, and Pennington is entitled to a new trial.
The Court of Appeals reviewed and rejected an appeal based upon the failure to give a mitigation of damages instruction. The Court recognized that, while there is a general obligation to mitigate damages, Pennington had failed in his obligation to demonstrate that it “feasible and reasonable” for Wheeler to mitigate, namely by acquiring through either purchase or lease a similar convenience store.
Saturday, September 8, 2012
Battle of Thermophylae
Today, by one reckoning, is the anniversary of the commencement of the Battle of Thermopylae in 480 B.C. The record is not clear – the battle may be dated to August 7-9.
Darius, King of the Persians, had invaded Greece in 490 B.C. Meeting an almost exclusively Athenian force at Marathon, his army was decimated while the Athenian force suffered relatively few casualties. A runner (so it is said) took off to announce the victory to the population of Athens. Just over 26 miles later he entered the city, announced “Nikomen” (victory) and dropped dead from exhaustion. Meanwhile, part of the Persian fleet had broken off to attack Athens. The force at Marathon marched back to the city, manning its walls as the fleet approached.
The Persian fleet and army withdrew from Greece.A decade later Xerces had succeeded Darius as the Persian King, and he resolved to subdue the Greeks. Gathering a huge army (said to be over a million but likely not larger than 100,000), he invaded Greece. A force led by 300 Spartan hoplites (heavy infantry) and several thousand others Greek troops, all under the command of King Leonidas, resolved to block the Persians at Thermopylae.
For two days the Greek forces, taking advantage of the small front, it minimizing the advantage in numbers of the Persian forces, fought them to a standstill while suffering minimal casualties. Those overwhelming numbers were, however, the basis of Dienekes’ boast, as reported by Herodites, in response to the assertion that the Persian arrows will block out the sun, “Good, then we will fight in the shade.” Ultimately, the Persians were shown how to outflank the Greek forces. Most withdrew while the Spartan forces, along with certain others, stayed as a rear guard to hold off the Persians as long as possible. In the last day of fighting they were annihilated.Notwithstanding the movie “The 300,” Leonidas did not fight in the final segment – he had already been killed. That is not, however, the largest problem in the popular understanding of the Greco-Persian Wars. The runner to Athens after the Battle of Marathon is not supported in the historic record, and is first recorded in the writings of the Roman Lucian.
Friday, September 7, 2012
Secret Profits Derived by Corporate Officer = Breach of Fiduciary Duty
A recent decision by the 6th Circuit Court of Appeals has further ratified the rule that a corporate officer, being a fiduciary to the corporation, is precluded from enjoying any secret profits related to that corporation. Mazak Corp. v. King, No. 11-5561 (6th Cir. Aug. 22, 2012).
King was Mazak’s Vice President and Controller from 1990 until 2005. Timothy Fisher, another Mazak employee, reported to King. In 1997, Louise Seta formed United International of Cincinnati, LLC, which provided consulting services to Mazak; Seta was Fisher’s brother-in-law. Ultimately, Seta, through United, proposed that it and Mazak set up an LLC to finance purchases by Mazak’s customers. This proposal ultimately led to the formation of Mazak Financial Group, LLC, it being 50% owned by Mazak and 50% by United. Not disclosed to Mazak was the fact that King, while still a Mazak officer, acquired an ownership interest in United and as well an ownership interest in W.T. Financial, a subcontractor of Mazak. Although the opinion is not express on the point, it would appear Fisher was as well an owner in one or both of those ventures.
After King’s separation from Mazak, reflected in a written separation agreement containing a release, Mazak learned, through United K-1s that King had an ownership interest in United. Mazak then sued King for various claims including breach of fiduciary duty and having aided and abetted Fisher’s breach of fiduciary duty. As the trial was about to begin, the trial court (Judge Bertelsman) determined, as a matter of law, that Mazak was entitled to an award of damages, and judgment was entered against King in the amount $3,472,896.
The Court of Appeals ruling considers numerous Kentucky decisions as to the obligations of a fiduciary to disclose any conflicting interest. For example, Aero Drapery is cited for the principle that:
If dual interests are to be served, the disclosure to be effective must lay bare the truth, without ambiguity or reservation, in all of its stark significance.
Based upon the fact that “King failed to disclose that he was simultaneously serving as a corporate officer and receiving payments from a company with which the corporation did substantial business,” “[t]he District Court correctly concluded that King breached his fiduciary duties to Mazak.” Relying upon cases including Stewart v. Ky. Paving Co., the Court made clear that the corporation need not show actual damages from the relationship (here, the companies in which King held an interest were not its competitors) in order to receive a disgorgement of the benefits realized by the disloyal fiduciary.
As to King’s assertion that the release in the separation agreement protected him from liability on the breach of fiduciary claims, the 6th Circuit was of the view that Kentucky courts would not read the release as sufficient to preclude a claim for breach of fiduciary duty when the facts as to the conflict transaction had been concealed from the corporation:
Accordingly, we believe that Kentucky courts would decline to enforce the release here. King did not disclose his ownership interest in United and W.T. Financial during his employment with Mazak or during the period when he served as a Mazak consultant. This information was clearly material to Mazak’s willingness to release King of all known and unknown conflicts of interest. Because King did not tell Mazak about his ownership interests in W.T. Financial and United while procuring the Separation Agreement, the mutual releases and covenants not to sue contained therein are unenforceable.
In addition, King’s effort to rely upon KRS § 271B.8-310(1) and its safe harbor from liability on conflict of interest transactions where it is shown that the transaction was “fair to the corporation” was rejected on the basis that the statutory provision relates to a conflict of interest between a corporation and one of its directors. King was not a director of Mazak, and the statute does not extend to officers.
The Mazak opinion is a useful reminder of the critical importance of disclosure obligations of fiduciaries in general, particularly its directions as to the measure of damages and the absence of a need by the corporation (or other beneficiary of the fiduciary obligation) to demonstrate actual damages. However, sadly unexplored by the opinion was the question of controlling law. Based upon a brief discussion with Mazak’s counsel, all parties to the dispute proceeded through both the trial and the appeal on the basis that Kentucky law would control. Mazak Corporation, however, is incorporated under the laws of New York, and under the internal affairs doctrine King’s obligations as an officer of the corporation would be determined under that law (whether the analysis would be materially different under New York versus Kentucky law remains to be determined). In contrast, as a common-law agent of the corporation, and to the extent those obligations were not modified by the New York law, Kentucky law would apply. Regardless of that issue, however, it is simply inconceivable that King’s actions would ever be considered appropriate.
Thursday, September 6, 2012
Idaho Supreme Court Confirms That An LLC and Its Members Are Distinct
In a recent decision, the Idaho Supreme Court has confirmed that an LLC and its members are legally distinct from one another. Stonebrook Constr., LLC v. Chase Home Fin., LLC, 277 P.3d 374 (Idaho 2012).
Idaho has a Contractor Registration Act requiring that construction contractors register with the state. Contractors that do not register with the state are barred from filing mechanics liens on property upon which they worked and are as well precluded from initiating suit claiming compensation for work performed. The statute goes on to provide that subsequent registration will not cure the prior failure to do so. Obviously, it behooves a contractor to register with the Idaho authorities prior to performing any work.
In 2007, Schwendiman and Burton organized Stonebrook Construction, LLC as an Idaho LLC. This company was the successor to a partnership between Schwendiman and Burton that had done business as “Stonebrook Construction.” In connection with those pre-LLC activities, Schwendiman registered as a contractor under his own name. After its organization, Stonebrook Construction, LLC contracted to build a house. Ultimately, it was not paid, whereupon the LLC recorded a lien on the property and filed a lawsuit to foreclose on it. Chase Home Finance held the deed of trust against the property; it intervened in opposition to the LLC’s foreclosure action. Chase moved for summary judgment on Stonebrook’s claim, asserting that the lien was invalid in that the LLC had not registered under Idaho’s Contractor Registration Act. The trial court agreed, dismissing the action, whereupon the LLC appealed.
Schwendiman and the LLC argued that Schwendiman’s individual registration should be sufficient. In effect, they sought to argue that Schwendiman and the LLC were jointly performing the work upon a provision in the statute addressing a “combination” of various “persons” working as a unit.
This argument was ultimately unavailing. The Idaho Supreme Court noted that an LLC is an entity separate and distinct from its members and that the members are not personally responsible for the LLC’s debts and obligations. Ergo, there was not a “combination” between Schwendiman and the LLC in the performance on this agreement. Rather, it was an obligation of the LLC.
The Court also rejected an argument of substantial compliance, noting that the LLC had not made any effort to satisfy the statutory requirement of registration.
In response to the argument that the Court’s interpretation of the statute was harsh, it wrote that “Although the result for [the LLC] is harsh, it is the result the Legislature intended.”
Wednesday, September 5, 2012
7th Circuit Reject Efforts to Hold Attorneys Liable for Client’s Securities Fraud
In a recent decision, the 7th Circuit Court of Appeals determined that the attorneys to the promoter of an investment security plan were not responsible to make good the investor’s losses when the venture ultimately failed. Rosenbaum v. White, No. 11-3224 (7th Cir. Aug. 16, 2012).
Chad Seybold, a securities broker turned real estate investor, enlisted the aid of attorneys Beau Jack White and James Beaman to assist in organizing an investment vehicle, a LLC, through which to purchase, rehabilitate, and then either sell or rent commercial real estate properties in Marion, Indiana. To that end, a pair of business entities were organized, one of which would be partially owned by private investors. Seybold was successful in soliciting investments in excess of $1 million for his plan. However, it failed shortly after launch; the opinion does not indicate exactly how long it took for the venture to fail, but it can be inferred it took place within a matter of mere months. In response, the investors filed suit against not only Seybold but also the attorneys. Seybold, individually, filed for bankruptcy. Ultimately, the suit was either dismissed or settled as all of the defendants save the attorneys. They sought and were granted summary judgment by the trial court, and the plaintiffs appealed to the 7th Circuit.
With respect to claims for legal malpractice, constructive fraud and securities fraud, the Court found that all three hinged on whether the attorneys owed the plaintiffs a legal duty, that being a question of law. Slip op. at 12. With respect to the claims of legal malpractice and constructive fraud, the court found that the facts did not support the existence of an attorney/fiduciary relationship between the attorneys and the individual investors in the venture, it being organized as an LLC. Arguing against the defendants’ position was the fact that Seybold, in the course of an oral presentation to some of the ultimate investors in the LLC, had indicated that the attorneys were working on their behalf, a statement not corrected by the attorney. However, analyzing the broader context of the discussion, including the explanation that the attorneys were hired to organize the LLC’s in question, the Court determined that these facts were not sufficient to create an attorney/client relationship. Rather, the statement was not made to all investors, many of the investors never met the attorneys, and language in the operating agreement inviting each investor to consult with their own counsel.
The court also rejected efforts to impose liability based on alleged violations of standards set forth in the Indiana Rules of Professional Conduct Governing Attorneys. Essentially, the Court upheld the rule, recited in those rules of professional conduct, that they do themselves create duties, rather those duties must arise at common law.
With respect to the alleged violations of federal and state securities laws, the 7th Circuit cited various holdings such Chiarella holding that the failure to speak cannot give rise to a claim for fraud absent a duty to speak based upon a fiduciary relationship. In that the attorneys did not stand in a fiduciary relationship with the individual investors, they had no obligation to speak in order to address the either ambiguous or misleading statements by Seybold as to the attorneys’ role in the transaction.
Ultimately, the attorneys work in the organization of the ventures and the related financing were not subject to criticism, and that being the case it is somewhat difficult to ascertain what would be the ultimate theory of recovery by the plaintiffs. Even in the absence of a breach of duty, there must be shown damages consequent to that breach. The attorneys in this case were not managing the venture and were not involved in its ultimate collapse, so the suggestion of their culpability for damages is at best questionable. With dismissal, they at least avoid having to make that demonstration.
Death of Katherine Parr
Today marks the death of Katherine Parr in 1548. The sixth wife of Henry VIII, she, along with Anne of Cleves, would unlike four other wives survive him.
Henry had children by three of his wives: Catherine of Aragon, Anne Boleyn and Jane Seymour (wives 1, 2 and 3). Catherine died of natural causes, Anne was rendered shorter by a head, and Jane died of complications from childbirth. Katherine Parr is one-half of the answer to a trick question - name the two wives of Henry VIII to have died from complications of childbirth. After Henry’s death Katherine married Thomas Seymour and for the first time in four marriages became pregnant. She died, however, in childbirth, the second of Henry’s wives to do so.
Tuesday, September 4, 2012
And So Begin the Middle Ages
By a certain measure, today marks the anniversary of the date in 476 from which the “Middle Ages” may be dated. On this day, the last emperor of the Western Roman Empire, Romulus Augustus (he was little more than a child and was completely controlled by his father, a Russian military commander), was deposed. The imperial regalia was packed up and shipped off to Byzantium. With this event, the Western Roman Empire ceased to exist, its fragments now under control of various “barbarian” tribes.